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Options to reform the EU emissions trading system

In recognition of the need to address the growing emission allowance supply-demand imbalance in the EU emissions trading system (EU ETS), the European Commission (the Commission) has launched a consultation setting out options for reform. The consultation follows a proposal that the scheduled auctioning of 900 million carbon allowances in the years 2013-2015 be delayed until 2019-2020. This comes at a time when phase 3 of the scheme has started, which sees a greater emphasis on the auctioning of allowances and fewer being available free of charge.

While the European carbon market is delivering emissions reductions, Connie Hedegaard (the European Commissioner for Climate Action) has announced that the oversupply of emission allowances in the market means that the EU ETS is not driving energy efficiency and green technologies strongly enough – the price of an EU allowance has fallen to its lowest level recorded in recent weeks, at just over €4 per tonne of CO2 equivalent. Consequently, the Commission has launched a consultation on options to strengthen the EU Emissions Trading System and increase the price signal for carbon. It has also announced that as an immediate short-term measure, it is proposing that the scheduled 2013-15 auctioning of 900 million allowances be deferred until 2019-20. This is designed to reduce the number of allowances offered in the short term, when demand remains low, and will make more allowances available later on, when demand is expected to have recovered.

Six possible options for the structural reform of the EU ETS are identified in the consultation:

Increasing the EU’s greenhouse gas emissions reduction target from 20 per cent below 1990 levels to 30 per cent below 1990 levels for 2020. This change would require the number of emission allowances in the EU ETS to be reduced via either option (2) or (3) below. This more ambitious cap would also have implications on the carbon market beyond 2020 as well as affecting the targets of non-EU ETS sectors.

Permanently retiring a number of phase 3 allowances from the EU ETS. This proposal would not change the number of emission allowances allocated for free or existing holdings of allowances and, although it would implicitly increase the reduction target for 2020, it would not directly affect the framework post 2020. This option could also be implemented by a separate decision (rather than through amendments to the existing EU ETS Directive) maintaining the regulatory stability of the wider legislative ETS framework for phase 3.

Increasing the annual linear reduction factor. The total amount of allowances under the EU ETS decreases by a linear factor of 1.74 per cent annually, in comparison to the average annual total quantity for the years 2008-2012. This linear reduction factor continues to apply after 2020, subject to any changes made to the ETS Directive – it would therefore impact the EU’s greenhouse gas reduction levels post 2020.

Extending the scope of the EU ETS to incorporate new sectors. This would involve including sectors within EU ETS which are less strongly influenced by economic cycles. This option raises several policy questions such as whether the EU ETS should target fuel producers, users or both. Consideration would also need to be given to how this measure would interact with existing policies applicable to those sectors.

Limiting access to international credits. The Commission considers that this option would increase certainty regarding the efforts required to be undertaken in Europe to reduce greenhouse gas emissions and would encourage indigenous investment in low carbon technologies. It is, however, acknowledged that this possible benefit may have to be balanced against the potential adverse impacts this option would have on financial flows and technology transfers to developing countries.

The introduction of a discretionary price management mechanism. It is proposed that two mechanisms could be employed to help support the carbon price temporarily, reducing the volatility of carbon prices and preventing price drops which result from temporary imbalances in supply and demand: a carbon price floor (primarily for auctions), to introduce greater certainty regarding minimum price, thereby assisting investors; and a price management reserve, which would be used to adjust the supply of allowances according to the price of carbon. The latter would operate to counteract any large temporary imbalance in supply and demand. It would operate to buy-back or release, as appropriate, emission allowances when specified price levels were triggered. Emission allowances could be permanently retired if the reserve reached a certain size. Such mechanisms would require new governance arrangements in order to determine the level of the price floor and/or the relevant trigger levels for the purposes of the reserve. Consequently, this option would result in the carbon price primarily becoming a function of administrative and political decisions (or expectations about them), rather than being the result of the interplay between market supply and demand.

Should the Commission decide to pursue any of these options, a legislative proposal would be needed, accompanied by a full impact assessment. Any proposal would then have to go through the normal legislative process.

The consultation closes on 28 February 2013 and the Commission has invited stakeholder submissions; dedicated stakeholder meetings may also be held in 2013.

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